We just sold $170k from our Muni Bond portfolio and will be using the proceeds to pay off our cabin mortgage. In a few weeks, we’ll be 100% Debt Free! Why the change of heart?

Today, I’ll explain our thinking.

Why We Just Sold All Our Muni Bonds (And Became 100% Debt Free)

You read that right. We just changed our minds, again, and sold $170k of muni bonds (where we’d been holding the equity from our Good Cabin sale since Oct 2017), and applied the $ to pay off our Great Cabin mortgage. After having been debt free, then assuming debt on purpose, we’re once again at the point of being 100% debt free.

The question I would suspect these schizophrenic actions raise among you, the reader, is:

I hope you can learn from my actions and the thought process used as I adapted our strategy based on the changing environment in which we live. Today, I’ll address those changes, and how they’ve affected our decisions. Think about decisions you’re facing in your world of personal finance today, and apply the lessons as they make sense in your own process.

First, a quick rundown of our first two decisions, and then I’ll get into what’s changed that caused us to shift our thinking yet again. Summarized below are both of our previous decisions, along with a bit of background on what was going on at the time.

1) Why I Was Happy When We Became Debt Free

We’re Debt Free!!! (for 18 months….)

April 2016 Summary: On April 12, 2016, I wrote the biggest check of my life, and paid off our cabin’s mortgage. We took a picture of it, wrote a post about it, and became 100% Debt Free(yes, a check. I did it on purpose. It was a big occasion….). We completed our planned downsizing move and used the equity in our “big city house” to pay off our mountain cabin home in its entirety. We had executed our plan. We were debt free!

2) Why I Was Happy When We Went Back Into Debt

October 2017 Summary: 18 months later, things changed, and we changed our plan accordingly. We decided tomove from Good To Great, and did a second downsizing move in less than 2 years (from a “good” cabin to a “great” cabin). After we sold our “Good” cabin we had a new decision to make during the purchase of the “Great” cabin. Do we roll over the home equity from the “Good” cabin and payoff our “Great” cabin, or do we assume a mortgage and invest the equity?

As I wrote about at the time, we decided to take on the mortgage and invest the equity. The main driver behind that decision was to create a low-cost option as we finalized my pension decision, and gave us flexibility as we finalized our retirement cash flow plans. Using this option, we were able to delay a final decision on whether or not we should tie up our liquidity with a payoff the Great cabin. The option to payoff the mortgage was available at any time.

We invested the home equity from the sale of our “Good” cabin into Vanguard Muni Bond fund (VWITX) in late October 2017:

That flexibility we gained by investing in Muni’s paid off, as you’ll see in #3 Below:

3) Why I’m Now Happy Selling Our Muni Bonds To Become 100% Debt Free

January 2018 Summary: Markets change. New Tax Laws Get passed. Put the macro forces together, and the math that previously favored investing the equity in Muni Bonds to retain flexibility on our cash liquidity now favors a different decision.

With the flexibility we achieved by #2 above, we were able to more fully evaluate our decision, which was helpful given the significance of the Tax Law change in January 2018. In the past 4 months, we’ve finalized my pension start date/amount, and have calculated the liquidity/income we’ll need to pull from our investments. We’ve also developed a strategy to take advantage of the New Tax Law Loophole, and have estimated the impact of our Before-Tax to Roth conversions on our taxes and investment withdrawal requirements over the next 3 years.

Knowing the gap helped us to identify how much liquidity we need for our Bucket Strategy. Turns out, we don’t need the extra liquidity we had available by holding the home equity in Muni’s. From a liquidity perspective, we could afford to pay off the mortgage and knew we wouldn’t get into a cash crunch as we transitioned into retirement.

We Made Our Final Decision.

This week, we decided to pay off the mortgage.

Bottom Line: The situation changed, and we changed our strategy as a result.

We’re now going to use the money to pay off our Great Cabin mortgage and become 100% Debt Free.

Earlier today, I executed the following trade to sell $170,000 from our Muni Bond fund at Vanguard:

In my humble (but deeply considered) opinion, the new tax law is going to have a negative impact on Muni Bonds, as well as a negative impact on the economics of carrying a home mortgage. Both of these impacts result in us being advantaged by selling the munis and paying off the mortgage.

I’ll summarize my thinking of the specific changes and their impact in the bullets below:

New Lower Income Tax Rates: With the new lower income tax rates, tax-free muni income becomes less attractive on after-tax, “apples to apples” comparisons to other investment options. The “tax-free” yield is analyzed using the marginal tax rate to determine the break-even point vs. taxable bonds, for example. Lower tax rates mean munis are LESS attractive than other alternatives. I suspect there will be some selling pressure on munis, further reducing their potential for attractive returns.

The Loss Of The Mortgage Interest Deduction: With the increase in the standard deduction to $24k (Married, Filing Jointly), we’ll be losing our mortgage interest deduction, given that our itemized deductions will total less than $24k. Therefore, the interest rate payoff on our mortgage becomes MORE attractive on an “after-tax” basis, since it’s no longer subsidized by the tax write-off. It’s just math….

Interest Rate Risk On Bonds: With an average bond maturity of 6 years in our muni bond fund, we would suffer a 6% loss in principle for every 1% increase in interest rates. We’ve seen a bit of decline in this fund’s principal since we invested in Oct, and further interest rate increases look likely. Bottom line: the interest rate environment increases our risk of loss in the Muni Bond Fund. Meanwhile, there’s 0% risk in paying off the mortgage early, and we lock in the 3.5% “return” which was our mortgage interest rate. 3.5% risk-free return looks reasonably attractive, given the alternatives in this “Everything Has A Crazy High Valuation” investment market.

My Income Will Go Down Post-Retirement: With a lower post-retirement income, my marginal tax rate will be lower than it is today (unless I decide to rollover $200k/yr of before-tax IRA money!). Even if I do large rollovers, the new lower tax rates result in an after-tax arbitrage that favors paying off the mortgage when compared to keeping the money in Muni-Bonds (the mortgage isn’t deductible, and the muni-bonds aren’t as attractive in a low tax scenario).

Our Mindset: After surviving the One More Year Syndrome, we’re in a good place from a financial perspective, and we can be more conservative with our investments. With a Withdrawal Rate of only 3.0%, we don’t need to take on excessive risk. As I commented in this article about risk from Financial Samurai, I believe you should only take on the risk you need to achieve your required investment returns, which in our case is “low”. We’re able to tolerate the lower return that comes with less risk, and we want to avoid any major losses early in retirement. So, we’re tucking our horns in for a while, and the 3.5% fixed rate (with no risk) we “earn” by paying off the mortgage is more than sufficient for us. With markets overvalued and concerns about Sequence Of Return Risk, we’re going into a defensive position for the first few years of retirement. 3.5% risk-free? I’ll take it.

Besides, looking at a 3.5% nominal return (1.0 – 1.5% real return) looks reasonable compared to this forecast for the returns over the next 10 years by Asset Class just published by Research Affiliates:

10 Year Expected Returns By Asset Class

What If We’re Wrong?

The good news about this decision is that there’s limited downside. Some folks, like my friend Nords are taking every bit of mortgage they can get in this low mortgage environment, feeling they can make higher returns by investing the money elsewhere. If Nords is right and I’m wrong, what do I lose? Not much, in reality. Perhaps a few percentage points of return on $170k. Not enough to change my retirement, and I’ll sleep well at night.

I like to sleep.

And….in case you’re curious, I’m sleeping well with this decision.

Conclusion

As macro forces evolve, it’s important to adjust your personal finance strategy accordingly. Sometimes it makes sense to carry a mortgage, and sometimes it makes sense to pay it off.

Take time to think about the impact that macroeconomic changes could have on your retirement situation. For example, with the new tax law being a significant factor, have you thought about how it may change your approach in certain areas? Are you going to leverage The Tax Loophole to reduce your future Required Minimum Distributions? Another potential “impact area”: If you’re thinking about relocating for retirement the new tax law would make it more important to find a state with low state and property taxes since deductions for state & local taxes are now capped at $10k.

Look at the process we used as we decided between paying off our mortgage vs. investing the home equity. It wasn’t an easy question to answer, as demonstrated by the 3 changes in strategy we’ve had in the past two years. Use our situation as a Case Study, and see if you can apply the process that we used in a decision that you need to make. Feel free to throw a question into the comments, we’ll look at your situation together.

Risks are changing. As interest rates appear to be ending a major “down” cycle and starting to turn “up”, the risk of owning bonds increases as their 30 year Bull Run looks to be reaching its final mile. As stocks reach valuations well above “normal”, the risk of a “reversion to the mean” increases the odds of a market correction in the next few years.

Risk is increasing, at precisely the wrong time for those approaching (or in) retirement.

Position yourself accordingly.

In our case, it meant paying off the mortgage. What does it mean for you?

I look forward, as always, to your comments. Am I schizophrenic, or does my logic make sense? Would you pay off the mortgage, or continue to carry the mortgage and hold the equity in an investment? If so, which asset would you hold, and why? Can you apply the process we used to a situation you’re facing? Let’s discuss it in the comments. (BTW, the comments has been FANTASTIC in my past few months. Thanks to all of you who interact.)

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50 comments

Your analysis of the math is good Fritz, and in the end who knows if you’ll be right or wrong. If we had that crystal ball…..

As far as the mortgage, as you stated, either you’re going to be right or Nords is going to be right. Personally, I’m still carrying my mortgage and I’m with Nords. I’m also a bit younger than you and would have time to recover from any big blow in the stock market. Like everyone else I believe this crazy bull market can’t keep going like it is. However, I think the new tax law and the benefit to business could perhaps lessen the blow of the pullback that is inevitably coming. So while I do think we will have a stock pullback coming at some point in the next couple years, I think the law that was just passed might make it relatively benign or minor.

Thanks for the compliment, AF. Being younger certainly would influence the “pay off vs. invest” dynamic. Too bad that crystal ball is so cloudy, sure would be useful when facing these types of decisions….

We’re 100% with you, Fritz! And that’s the beauty of personal finance. After reading the comments on Sam’s post yesterday, I was excited to see your comment about paying off the mortgage. We paid off a $68,000 mortgage yesterday too! One more to go – and we’ll have three paid off properties and zero debt. Could we be investing more? Sure. But we are working on increasing our cash flow right now too. It’s what helps you sleep at night that matters most – especially when you have lots of options. Congratulations!

I’m working on paying off my mortgage now, although I’m not so near to retirement. Hoping to have it gone before I’m 40. And I agree with the recent tax law changes it’s a better deal than every to pay it off. The only thing for me is that my rate is 2.75%, and I’m saving for the payoff in a separate account rather than sending it to the mortgage company. I was just able to get a 1.5% rate on a money market account, and I’m old enough to remember the days of 4-5% risk free interest. If risk-free rates go above 3% I may rethink my strategy.

Being 100% debt free by Age 40 would be a MAJOR accomplishment! I have to admit, that 2.75% would certainly make me pause, that’s the lowest mortgage rate I’ve heard of anyone actually locking in. Congrats on building options!

Talk about schizophrenic — city apartment during the week, great house on the weekend, crazy work travel. When you no longer march to someone else’s schedule everything is going to feel very different. This is the best time in your life to NOT have a mortgage! It clears the slate for you to start fresh and be very intentional about life going forward. Congrats!

Congratulations, Fritz… again! I like that you’re willing to adapt and think through changing circumstances to give yourself an upper hand when possible. As you said, “Markets change. New Tax Laws Get passed.” What may have made more sense before might not be the best move now. That’s got to be amazing to be 100% debt free… again! 😉

Hi Fritz, maybe the cold water swims are getting to you?! Just kidding!
“…gave us flexibility as we finalized our retirement cash flow plans.” That’s the key! Flexibility and planning. Not a thing wrong with taking some months to figure it out. Congratulations on being debt-free (again)!

Congratulations! We’ve been struggling with that same decision but we will likely do the opposite. We need to stay in high tax NY for about three years for family reasons. Our short term goal is to minimize how much we have to withdraw from our retirement accounts to avoid paying more taxes on that money than necessary. We have a few large projects to do around the house (modest but necessary to sell in this market) and rather than pull from our emergency fund (2 years living expenses in case the market goes down in retirement) or retirement accounts, we are looking at refinancing for a longer term and pulling out some equity. We will then pay for the improvements with the cash from equity without paying tax and considerably lower our mortgage payments for the time we are here (again, reducing the need to pull from our retirement accounts and paying taxes). We’ll also enjoy the improvements for the time we have left here. Sounds a bit convoluted but even with the closing costs to refinance the numbers seem to work for us. We plan to buy a new home in a lower cost state with the net proceeds from this house when we finally move and don’t plan to carry a mortgage on the next house and so debt free is in our future too!

How much did that mortgage cost you? In interest and fees, closing costs? On the time you were paying off the mortgage, how much of each monthly payment went to principal and how much went to interest? How much did you lose on the muni bonds? Looks like you purchased $180K of muni bonds yet you sold $170K worth. Does that mean you lost $10K or is that $10K still with those muni bonds?
Sounds like to me you lost money all around.

Cindi, we still have the +$10k in Muni’s (plus other cash we’ve invested there). We paid 3.5% interest on the mortgage (tax deductible), and earned ~2.2% on the muni’s (tax free). I’d have to look back at the closing costs, but in our mind the optionality was worth the expense.

Nobody can make the right call 100% of the time (even someone still using paper checks 😁) but your decision is well thought out and low risk, so even if you’re wrong you’ll still be in an envious position!

I see what and why you did it but as a slightly early retired couple there is no way I’d ever agree to owe anyone another penny ever in this life. Leverage is risk and now that I’m totally FI why take risk that you don’t have to? While I admit it is a judgement call I bet you’ll sleep better now. On the muni’s the new tax bill isn’t exactly new news. If you believe there is market efficiency then the tax impacts on muni’s are already priced in.

This is so informational and just fascinating to read! There’s nothing wrong with 3 changes of heart, the world of taxes changes all the time. It’s definitely smart to adapt with it and you have thought about it well in your explanation.

I know that feels absolutely delicious! Being debt free is such a wonderful accomplishment and such a glorious feeling. Your position leaves you flexible and able to adapt whatever the heck the markets do. I sold my too big, too expensive American Dream house very recently and decided to be a renter at this point in my life to help me escape wage slavery more quickly. I have become miserable not owning 100% of my time even if it means I have to leanfire and side hustle. I help my boyfriend out by paying “rent” and he pays his small mortgage down sooner. The downsizing to a very small space has a few limitations (especially for me as the “new hobby every week” girl) but it also has brought peace, ease, flexibility – especially with finances as I contemplate leaving work in a few months and exploring all my new and continually evolving interest. I really appreciate reading about your struggle in making this decision – this exemplifies the fact that there’s never one right one size fits all answer.

BB, thanks for your first time comment on my blog! “Delicious” seems a stretch (apple pie and ice cream comes to mind), but I have to admit it feels pretty darn good! Congrats on your downsize move, we also sold our “big city house”, and the resulting feeling of freedom was delicious.

Nice and congrats. I recently paid off my low interest student debt instead of investing during this bull market…could I have made more money? Sure, but like you…I like to sleep. Can’t go wrong being debt free.

Being “Debt free” is a great feeling, only when we are used to having debt and feeling the pain of debt. Growing up, my parents and grand parents had no debt. No consumer or mortgage debt. They lived in small houses (<400 sft), with no air conditioning (In Indian tropical climate). Their assets were also very minimal. 80% of monthly income went to buy food. Rest went into savings in gold. They bought one pair of clothes for their birthdays, and one for new year. We used well water, and no plumbing inside the house.

Hari, what an inspirational story. I suspect many of the readers of this blog have grown up in a world of relative privilege. I was talking with a co-worker who just returned from a week long Habitat For Humanity build in rural India, and we talked about how fortunate we were just being born in a country like the USA. Thanks for reminding us all of how blessed we really are, and thanks for taking the time to comment.

Always enjoy your posts Fritz, and I wondered how long it would take for you to see that debt free is always better, since we can never truly know all the risks, including job, health and politics. My sister just received a glowing review from her health company where she is a nurse case manager. Her and her team were the highest return for the company for the year. That was Thursday and then on Monday she was told the team was laid off and she would get 2 months severance. Debt free and an emergency fund is going to save her bacon. Who knew?

So sorry to hear about your sister, glad she was prepared. Nothing is for granted, and elimination of debt certainly reduces risk. Sometimes, I’m just slower than others at coming to the right conclusions! I blame my schizophrenia.

Funny, we’ve been debt-free for over 15 years, and I just got the idea of borrowing against our 2 rentals. We take the Obamacare subsidy and the rental income has tied our hands to making Roth conversions. After reading a post from Big ERN, I realized leverage on the rentals might make sense. I guess I’m schizophrenic too!

I also agree with your observation about bond duration risk. I don’t think people have their eye on that one and believe bonds are so safe. Thanks for sharing such a big decision.

Informative article and congrats on being debt free. Also, good analysis regarding the changing tax law and the loss of the mortgage tax deduction in your case. There will definitely be fewer taxpayers itemizing over the next several years.

Tough to give up a 3% or so mortgage (15 or 30 years fixed?). But if you have no need for the extra return and sleeping better at night is your main objective, then I see the logic in it.

For someone in a similar position who wishes to stay invested but is worried about an impending spike in interest rates and inflation, another option would be to sell the munis, and then dollar cost average the lump sum over a period of 18 to 24 months into a more diversified portfolio consisting of a mix of asset classes. This way you reduce risk by diversifying and easing your way back into the market, while also lessening the opportunity cost of not being invested.

Then again, you still have the option of doing the same DCA with the money saved from not having to pay the mortgage each month. Although this would be a much more gradual DCA.

I considered your point about dollar cost averaging into other assets, but my primary objective with the home equity money was liquidity, either for my first 1-2 years of retirement or to pay off the Great cabin mortgage. With valuations as high as they are today, I’d have been uncomfortable taking on the risk given the short term liquidity requirements for the money. Thanks for being a “Thinker”, and contributing to the discussion!

Your articles always provide useful information – many times about topics that I have thought about as well. We are considering early retirement in a year or two (just prior to age 50). Our retirement accounts are currently 7 figures, and will conservatively be worth $3 million at age 60. What are your thoughts on taking advantage of this loophole in our situation?

Thx for sharing your thought process. It gives us another point of view to consider.
I like the sleep well argument: the best there is! A decision does not need to be financially optimised, it also needs to optimise the impact on your life and goals.

In my personal case, with an interest rate of 0,6 pct for the next 3 years, I keep the mortgage. Even if I would love to he mortgage free and offer my wife a half time job… One day!

Another great post! I tend to follow your blog pretty closely as I find myself closer to your situation than those shooting for very early retirement. We’re the same age and I’ve been struggling with one-more-year syndrome. Just paid off the mortgage a few months ago and own one rental free and clear. Quandary now is where to move 401k funds as potential retirement gets closer. With Vanguard S&P index, total bond fund, and money market fund as only choices, I’m tempted to move a large percentage into the MM fund for the initial phase of retirement to smooth the glide path. Schizophrenia feels like an apt diagnosis for my daily flip flops on this decision. Have really enjoyed reading your thoughts thru this process.

Scott, thanks for your note, it means a lot to me to know I’m helping others in a similar situation.

I struggle with your same question about “where should I put my money”. I, too, have been tempted to move a large chunk to MM. EVERYTHING seems over-valued right now, and we’re facing a potentially significant sequence of return risk. At the same time, we have to keep invested for the long term.

At a minimum, make sure you have 3 years of cash in MM (Bucket 1). That’s what I’m working toward now, and it will likely entail selling off a few equities/bonds to get there. Previously, I had considered bonds as reasonable assets for Bucket 1, but now I’m not so sure given the increasing interest rate environment, and risk of principal.

This one may warrant a future post….hope you don’t mind if I reference your comment? Thanks for being a loyal reader, and good luck with your schizophrenia.

Well played, my friend. Well played. The $24K standard deduction is such a game-changer for those who carry a relatively small mortgage and live in a low-tax state. In your situation, the odds tilt decisively toward being debt-free. And now you can safely thumb your nose at sequence-of-returns risk. Hail the $24K standard deduction! Hail Georgia!! Hail being completely debt free!!!

That’s a great decision. I’m sure you won’t regret paying off that mortgage.
The 10 year expected returns are so low for everything. It’s depressing.
We’re planning into our rental and sell our current home. That should bring in some cash. I need to figure out what to do with it. Paying off the mortgage sounds more and more attractive.

Agree on the conservative investment approach considering sequence and market risk in early retirement when one has “enough”-we have similar plans, albeit with slightly different execution plans (TIPs ladder and somewhat less cash), and are fairly well protected from downside risk. We are not big spenders but one of the advantages of a TIPs ladder is managing spending risk while maintaining some liquidity. About 30% of the portfolio is in a few ETFs in Roth, only to be used later/if needed-that’s it for market exposure-hopefully it will grow some but if doesn’t we will be OK. Its pretty (ok to some folks it’s very) conservative but sleeping well is highly underrated!

Rob, we’ve considered TIPs ladders, as well. Are you managing it through individual bond purchases, or via ETF/Mutual Funds? I suspect you need to buy individual bonds to make the ladder? I’ve considered Guggenheim dated funds, as well.

I think you made the right decision, particularly for your situation. I am totally aware of the math regarding our mortgage. We have a 2.875% interest rate and about 10 years left, but this isn’t our forever home and maybe not our forever area. I am torn between investing as much as I can and the debt being gone. However, if I did put the money in the house they will give me a check when we sell it and we will sell it. I just don’t like having debt and sometimes the “heart” of the matter with finances overrules the head and that isn’t a bad thing.